Why Dollar Stores Are a Better Bet Than Big Box Retailers Right Now

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When Walmart sneezes, the retail sector catches a cold. That was particularly true of the dollar stores after Walmart lowered its full-year guidance in late July, but investors should think twice before turning their noses up at the stocks.

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Retailers have been under particular pressure this year, as inflation-strapped consumers are being forced to make harder choices. That reality was on display during first-quarter earnings season in May, when both Walmart (WMT) and Target (TGT) disappointed; and again in June, when Target lowered its guidance for the second time in a month.

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The big box stores cautioned that shoppers had rapidly shifted away from pandemic-popular categories—think clothing, home goods, and electronics—in favor of essentials, prompting hefty, margin-crunching discounts to move overstocked merchandise. That warning triggered selloffs across the industry, including dollar stores, which cater to lower-income consumers who are hurting the most from inflation.

Yet that view of Dollar General (DG) and Dollar Tree (DLTR) is too simplistic. “When you are forced to buy what you need rather than what you want, dollar stores shine,” says Mark Giambrone, head of US equities at Barrow Hanley Global Investors.

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That’s because inflation or not, shoppers still need to buy some goods, and with tens of thousands of locations throughout the US, dollar stores are often accessible to more Americans, particularly at times of high gas prices.

“No one needs T-shirts anymore but if you need toothpaste, you’re going to walk somewhere you perceive as having good value,” says Giambrone. “As people trade down, dollar stores tend to keep some of those customers even as the economy improves.”

That’s made dollar stores a good bet, both in good economic times and bad. Dollar General stock is up 381% in the 10 years that ended June 30, and Dollar Tree gained 210%, compared with a 174% return for the S&P 500 in that period.

More recently, both Dollar General and Dollar Tree in May delivered great fiscal first quarters, just days after gloomy reports from Walmart and Target that sent the industry reeling with apparel and appliance markdowns.

“Defensive retail selling nondiscretionary goods are going to be in a better place as we get through this inventory glut; grocers are fundamentally well positioned, dollar stores even more so,” says John San Marco, portfolio manager at Neuberger Berman’s Next Generation Connected Consumer exchange-traded fund (NBCC).

Dollar General is the clear favorite of the two, with good reason. The company’s sales mix skews more toward essentials over discretionary purchases than Dollar Tree, and while that company has been bogged down for years by the quagmire of its Family Dollar acquisition, Dollar General has an exceptional track record of sales and earnings growth.

Jefferies analyst Corey Tarlowe, who has a Buy rating and $285 price target on Dollar General, says the company “has a really defensive moat” around many of the small towns that “no other retailer services.”

He argues that “people who live in these rural areas don’t want to drive 30 miles to the nearest big box store all the time, but they will go a few miles to Dollar General. Dollar General is a nice fill-in trip and because of the way it’s [grown its store size] over the last several years, it’s become a fuller fill-in trip,” he says, referring to the company’s addition of more fresh produce and pantry staples that allows for bigger shopping trips.

Investors however didn’t care much for that nuance during retail’s recent routs. “Dollar General got destroyed [on the Walmart and Target news]and that’s a great buying opportunity…to pick up some shares at a significant discount,” says Giamborne.

Dollar Tree is more of a question mark, given its greater discretionary mix of items and ongoing issues at its Family Dollar chain. Yet on the plus side it pulled off a beat-and-raise first quarter, has upped its base price to a more margin-friendly $1.25, and sports a revamped board of directors, which includes a Dollar General veteran. If the next couple of quarters show that it’s making real changes, it could be a catalyst for the stock.

Either way, as expectations fall for Walmart’s and Target’s coming second-quarter reports—due out later this month—dollar stores could pull off a repeat of their outperformance.

“This earnings season, dollar stores could once again turn into stronger reports than the big box stores,” says San Marco, citing their different merchandise mix.

Of course that’s not a given, and if the past few months have taught investors anything, it’s to expect the unexpected when it comes to retail.

However both stocks are trading around 19 times forward earnings, not far off their five-year averages, at a time when the broader economic backdrop is pushing more consumers to bargain hunt. Therefore their earnings may be less subject to lowered revisions than other retailers.

In other words, investors aren’t paying much of a premium to own discounters that give them more bang for their buck.

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Credit: www.marketwatch.com /

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